STAR WEALTH PARTNERS
First Quarter 2016 Commentary
April 19, 2016
Dear Investor,
The first quarter of 2016 reminded me of my childhood….more specifically Mr.
Toad’s Wild Ride at Disneyland, which is one of the few remaining attractions that
was operational on the park's opening day in 1955.
The unexpected dips, turns, dark spots and ascension brought new meaning to the
colloquial caution “Please keep your arms and legs inside the car at all times and
do not stand up.”
The good news is while our investment portfolios were jostled and jolted, the
constitutional design of our portfolios held fast and performed as designed.
And now we must thank you, our clients for your support as we navigated the wild
ride and in the end were able, in most cases, to deliver modest positive returns on a
net-of-fees composite level within our STAR Spectrum, VEGA and Alpha programs.
Currently, we are cautiously optimistic about the near term return prospects and
invite you to read on as we lay out what happened, and how it affected your
investment returns. And what we believe will happen and what we are doing to
seek returns and avoid material losses where possible.
Sincerely,
David Young, CFA
Chief Investment Officer
Strategy Update
Early in the quarter in many of the STAR Spectrum strategies, we reduced our positions in
assets that we considered likely to underperform amid prolonged instability. In so doing we
created an enhanced cash cushion in the amount of 8% of funds under management. We
are poised to redeploy and we have identified the following conditions as worthy trigger
points:
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Widening credit spreads. Historically one of the most accurate indicators of stress on
the financial markets: when the spreads on high-yield debt widen, prices decline and
it's time to buy.
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The Fed raises interest rates. Should hawks prevail at the Open Market Committee
meeting late this month, we'll be ready.
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Britain exits the European Union. Markets throughout Europe would rattle, potentially
creating an abundance of cheap equity.
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Corporate buy-back fizzles. If buy-backs on Wall Street dwindle meaningfully ahead of
earnings results, share prices could follow.
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Energy markets stabilize. We'll consider a sustained, $40-a-barrel crude price as bullish
for the energy sector in particular, and the economy as a whole.
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Summertime earnings inspire. If Q2 corporate earnings hold firm, we plan to redeploy.
MARKET COMMENTARY
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We expect Q1 GDP to grow at an annualized rate of 2% or better, in line with the
market consensus.
S&P 500 Index ended in positive territory by 1.4% after sharp declines to start the year.
The rate on the benchmark 10-year U.S. Treasury bond continued its choppy decline,
to 1.8% at the quarter's end having entered the year at 2.2% percent, as investors
sought shelter from turbulent markets.
An uncertain credit environment continued jitters about the Chinese economy and
soft source data from Washington made for volatile, data-driven markets. Case in
point: a strong March jobs report kindled the prospect of higher interest rates days
after stocks staged historic rallies in response to dovish signals from Fed-head Yellen.
Inflation remains below target rates, hovering around 1% to 1.5%.
Precious metals were big winners for the quarter while the dollar unexpectedly
tumbled.
Emerging markets did well for the quarter as the EM Index climbed 5.7 percent for the
quarter thanks to a 13.2% gain in March. EAFE markets also enjoyed a strong March but
ended the three-month period down 3.0%.
Yellen's market-friendly speech last month chased share prices to a new peak for the year
as bond yields tumbled. We fear that unless the Fed gets serious about the current global
liquidity glut a new generation of asset bubbles is inevitable.
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MARKET OUTLOOK
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We believe the global economy will avoid recession thanks to steady, if not inspiring
U.S. growth.
With interest rates languishing, bond yields will suffer alongside strong equity markets.
We forecast the Fed will tighten credit at least once during 2016 and we hope it will
continue to adjust its policy rate higher - from 0.50 to 0.75 basis points - to pre-empt
asset inflation.
Though we are confident energy prices will defy the historic lows of the last three
quarters, price volatility is unavoidable given continued Middle East instability.
Dollar's dominance was rendered uncertain by Yellen's speech and bullish job growth
in March.
We anticipate little more than single-digit returns from equity and fixed-income
markets for the calendar year.
PORTFOLIO RECAP
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Our exposure to equities hampered returns and led to fierce volatility during the
quarter.
Reducing non-U.S. equity, high-yield and emerging-market bonds mid-quarter
mitigated the stress of market instability worldwide.
One bright spot this quarter: U.S. large caps, our largest single allocation of asset class.
Emphasizing yield from fixed-income assets stabilized returns, but came at the expense
of full participation in the fixed income rally fueled by a further decline in interest rates.
The alternatives allocation performed roughly in line with other risk assets for the
quarter.
PORTFOLIO STRATEGY
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Reduce US equity overweight to neutral.
Maintain lower allocations to Non-U.S. equity markets.
Look for attractive macro-economic, fundamental, valuation and technical
conditions to redeploy our significant cash cushion in applicable strategies.
Short to intermediate fixed income maturity and interest rate exposure to minimize the
impact of rising or volatile interest rates.
Emphasize high quality yield enhancing corporate credit / MBS / ABS, fixed income
allocations.
Limited & reduced exposure to High Yield and Emerging Markets debt.
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Market Commentary
ECONOMIC
We stand by our projections of annualized U.S. economic growth of between 2-3%
given the fourth quarter's adjusted 1.0% growth, signs of rising inflation and continued
new job creation.
Non-farm payrolls grew by 215,000 in March, thanks to growing demand in the
construction, health care and retail sectors.
The unemployment rate rose slightly to 5.0% from 4.9% because of an increase in the
labor-force participation rate to its highest level since March 2014.
Core inflation is forecast to reach 1.7% percent on the year, up by 1.5% the following
year but still below 2.0%, which the Fed has identified as a trigger for the boosting of
short-term interest rates. The gradual increase in prices suggested a waning of spare
capacity as consumer spending rose in February by an inflation-adjusted 0.2%, up from
a 0.4% decline in January.
The household saving rate posted first-quarter growth to 5.4%, up from 5.0%, though we
note that previous quarterly savings increases have eroded in revision.
Manufacturing also rose in March despite the biggest drop in industrial jobs since 2009.
Recent declines in the dollar can only be good news for industrials, if not for their
diminished work force.
Though oil prices have stabilized in the $30-to-$40 a barrel range after testing 11-year
lows early this year, both Saudi Arabia and Russia refuse to cut production for fear of
losing market share to American producers even as Iranian crude enters the market as
part of the U.S.-Iran agreement to restrict Tehran's nuclear program.
The energy sector continues to struggle with problems of oversupply, geopolitical
tensions and infighting between OPEC and non-cartel producers.
Gold, meanwhile, enjoyed its best quarterly gain in thirty years as it asserted itself as a
safe haven.
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FIXED INCOME
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The yield on the 10-yr Treasury note decreased from 2.2% to 1.8%, the steepest
quarterly decline in three years.
Yields remained stubbornly low despite the strong job report unveiled last week,
suggesting traders are not convinced a tighter job market will impel the Fed to lift
borrowing costs anytime soon.
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FIXED INCOME continued
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The Barclays Aggregate Bond Index returned 2.8 % in the first quarter.
Investment-grade corporate bond spreads tightened in the month of March.
The average spread of the Morningstar Corporate Bond Index began the year
at +168, peaked on Feb. 12 at +215, and then narrowed to +166 by March 22.
Credit spreads on asset-backed securities traded within their widest bands in
recent years, drawing investors into that market in search of yield.
Fixed Income Spread Analysis
Source: Barclays, JPMorgan, BofA, Merrill Lynch, US Dept of Treasuries
Data as of 03/31/16
EQUITY
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Share prices finished strong for the quarter after an apocalyptic start that bottomed
out in early February. The S&P 500 crawled back to eke out a quarterly gain of 1.4%
while smaller-cap stocks finished 1.5%in the black. Even the S&P energy sector finished
4.0% ahead owing to a mild rebound in crude prices.
The Russell 200, meanwhile, shed 1.5% for the quarter but finished strong in March,
gaining 8.0%.
By itself the March job report is unlikely to place renewed selling pressure on shares.
Fun Fact: The second quarter of election years has the worst average historical return
of the four-year Presidential Cycle.
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Market Commentary
INTERNATIONAL & EMERGING MARKETS
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The MSCI Emerging Markets index jumped 5.7% for the quarter. Despite this, the
outlook for emerging market investment remains clouded by depressed
commodities prices and sluggish growth in Europe and Japan, to say nothing of
geopolitical concerns.
The dollar posted its biggest quarterly percentage loss in over five years - more than
4.0% in the first quarter - after months of dominance.
The European Central Bank (ECB) cut projections for the 19 member euro-zone
economies - to 1.4% this year - and reduced its deposit rate to minus 0.4%.
Global equity in developed markets, as measured by the MSCI EAFE Index, posted
a 3.0% loss in the first quarter.
China's central banker declared an exchange-rate "return to normalcy" after
months of uncertainty over the Chinese economy prompted sharp selling of its
currency, the yuan. The specter of deflation continues to haunt the economy,
however.
This month, Standard & Poor's lowered the outlook on China's double A minus rating
from stable to negative, in line with a similar move by Moody's in March.
CASH
US BONDS
US HIGH YIELD BONDS
US STOCKS
US SMALL CAP STOCKS
GLOBAL BONDS
GLOBAL STOCKS
EMERGING MARKETS BONDS
EMERGING MARKETS STOCKS
Q1 2016
↑
0.01%
↑
3.04%
↑
3.25%
↑
1.35%
-1.52%
↓
↑
6.74%
-3.01%
↓
↑
5.22%
5.70%
↑
Q4 2015
↑
0.01%
↓
-0.56%
↓
-2.17%
↑
7.05%
3.59%
↑
↓
-1.15%
4.71%
↑
↑
1.55%
0.66%
↑
Market returns
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Market Outlook
ECONOMIC
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We expect earnings growth to erode despite high multiples of an overly optimistic
market.
Companies have gradually converted debt into equity in their capital structures while
still paying out dividends. Cash balances are also very strong suggesting corporates
are running lean operations and are thus suited for expansion.
Continued low energy costs and rising incomes due to a tightening labor market
should offset eroded buying power as a result of dollar weakness.
Though commodities prices, led by crude oil, have recovered from their winter lows
and valuations remain cheap; we continue to underweight the energy sector.
FIXED INCOME & EQUITY
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We continue to bake myriad global risks - from jihadi violence to divergent monetary
policies - into the outlook.
We expect high volatility to prevail at least until mid-year and in turn we have
increased our exposure to short-term, high-quality debt in sectors with strong cash
positions and enhanced fundamentals.
We favor exposure to shorter-dated credit with sensible credit ratings in sectors with
strong cash positions and improving fundamentals.
We have reduced our holdings in Europe and Japan and increased weightings in
large-cap U.S. stocks in search of value over growth.
We expect value investing is expected to outperform growth beginning in 2016.
2016
Real GDP Growth
FLAT/DOWN
2% -3%
Unemployment Rate
FLAT/DOWN
4% - 6%
FLAT
1-2%
10 Year Note yield
UP
2.50%+
S&P 500
UP
5% +/-
Inflation
Key annualized forecasts
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Market Outlook
INTERNATIONAL & EMERGING MARKETS
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The political and economic challenges facing the global economy "Ex-U.S" are
forbidding.
Despite assurances from Beijing, we believe the Chinese economy is in the early stage
of an epic, long-delayed retrenchment that may well elude the grasp of the
leadership. Deflation, diminished growth and political instability are distinct possibilities.
The euro bloc and Japan have been pushing on negative interest rates with little to
show for it. Europe is grappling with a refugee crisis and the not-unrelated scourge of
terrorist violence.
We anticipate more weakness in emerging markets as economies and companies
adapt to China’s “new normal” of slower growth. To complicate matters,
commodities-giant Brazil is embroiled in an executive-level political crisis even as it
struggles to beat a recession.
U.S. Interest Rate Scorecard
The following fundamental and technical factors point to yields on 10-year US Treasuries
fluctuating between 1.5% and 2.5% in 2016. We expect one to two more policy rate hikes in
2016.
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Current Strategy Summary
Fixed Income
Equity
U.S.
U.S.
DURATION
1 - 3 YRS
OVERWEIGHT STOCKS
0 - 5%
CURVE POSITIONING
Short/I nt.
DIVIDEND YIELD
5 - 10%
U.S TREASURIES
-10 - 0%
MEGA CAP
10 -15%
MORTGAGES
20 - 30%
LARGE CAP
25 - 35%
INVESTMENT GRADE CREDIT
20 - 30%
SMALL CAP
5 - 10%
HIGH YIELD
10 - 20%
MUNICIPALS
0 - 5%
Non-U.S.
Non-U.S./Alts
NON-U.S. DEVELOPED
0 - 10%
NON-U.S. DEVELOPED
5 - 10%
EMERGING MARKETS
0 - 10%
EMERGING MARKETS
0 - 5%
CURRENCY
0 - 5%
ALTERNATIVES
10 - 15%
DISCLOSURES
Past performance is not indicative of future returns and there is always a risk of loss of principal with any strategy. This client letter is published by
Partnervest Advisory Services LLC and is provided free of charge. Any stated or implied recommendations herein are of a general nature and clients
should consult with their investment advisor representative for advice concerning their particular situation. Information from third party sources is
deemed but not guaranteed to be reliable. Due to varying needs and circumstances, allocations and performance of individual accounts may differ
from their corresponding STAR model as well as the Current Strategy Summary. The Strategy Summary is designed to be general in nature and
reflects our overall opinion as to the relative strength of the represented asset classes. All asset classes may not be in your particular portfolio nor
within the targeted allocations.
This is NOT a solicitation for the sale or an offer to buy any security including, without limitation, the Advisorshares STAR Global Buy/Write ETF.
Securities may only be offered through a prospectus. Partnervest earns fees for providing investment advice to the ETF in addition to fees earned by
managing client assets. For more information please visit http://advisorshares.com/fund/vega
Indices do not reflect actual portfolios or trading and the stated returns do not include investment management fees, transaction fees, dividends and
other earnings and the timing of investment decisions, thus, they are not necessarily indicative of the allocation or return that an actual managed
account in the future will or would have achieved. Partnervest strategy performance, if depicted, is net of fees. For additional details on this, or any
of the investment strategies offered by Partnervest, please consult your investment Advisor. Investment management services provided through
Partnervest Advisory Services LLC. Subadvisory Services, research, charts and data in this newsletter is provided by Anfield Capital Management, LLC.
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